Starting your kid’s Roth IRA

Earlier this month, noted CFP & military veteran Jeff Rose was running a financial seminar with a roomful of college students. These seniors are graduating in a couple of months to (hopefully) earn the big bucks for their retirement accounts. He wanted to suggest ways to start on their own financial independence, so he asked them who knew what a Roth IRA was.

Over 50 young adults in the room. Not a single hand went up.

Jeff’s started a Roth IRA movement to call attention to this awareness problem. Over 135 personal-finance bloggers are hitting the subject today. I can’t wait to see how the blog statistics turn out.

I’m blogging for grownups here, so I’m not going to tell you how to start your Roth IRA. You probably already know about Roth IRAs, and I hope you already have one. If you’re just starting your military career, then please save the money and start your Roth IRA soon. (Even if you already have a military retirement, you can still fund an IRA with earned income from a bridge career.) If you’ve been deployed to a cave or living underwater for the last few months, then you still have a couple of weeks left to make your 2011 Roth IRA contribution. If you have other questions, then Bankrate is hosting a Tweetchat today at 3 PM EST. (Hashtags are #dlrchat and #RothIRAMovement.) Or post a comment here, or send me a private “Contact me” note.

I’m going to focus on a niche aspect of Roth IRAs. If I’m blogging about Roth IRAs with over 135 140 other bloggers, at least 134 of whom have more traffic than I do (for now!) then I’m not going to get much traction with “How to start your Roth IRA“. I’m also not planning to talk about incredibly complex topics like “Can you get rich buying rental property with your Roth IRA?“. (Hint: No.) Instead, I’m going to discuss helping your kid start their Roth IRA.

Here’s the problem. You want to help your kid save for college, or at least help them move out of your house and into their first apartment. You want your kid to put their earned income somewhere that belongs to them, somewhere safe where it can begin compounding away, and somewhere that it’s not burning a hole in their pocket every time they walk by an electronics store.

You could persuade them to contribute that money to a 529 college savings account, but what if they get a scholarship or don’t want to go to college? You could put that money in their savings or in a taxable account with a mutual-fund company, but then they pay might have to pay taxes on the earnings. (Their investment assets also count against them if they’re seeking financial aid for college.) You could help them open their first checking account or show them how to buy a CD, but those won’t solve the problem of sequestering the money away from their next spending spree.

Ah, but a Roth IRA solves nearly all of those problems. Once your kid starts earning their own income, they can put it away in an account that could compound for decades. It’s safer than their piggy bank. You don’t have to pay taxes on the earnings. It’s not restricted to college expenses, and it won’t count against their federal financial aid. It’s also hard for them to blow it on lifestyle while they’re still developing their delayed-gratification skills.

So what’s the minimum age for opening a Roth IRA?

There isn’t one. Your kid just has to have earned income and find a financial company willing to be the custodian. You, their parent or guardian, will probably have to sub-custody the Roth IRA account for them until they turn age 18.

If your six-month-old baby lands a gig as a photographer’s model, then their earned income can go straight into a Roth IRA. If your eight-year-old washes cars in the neighborhood, and then mows neighbor’s lawns and walks their dogs, they can open a Roth IRA. When your 14-year-old comes home with their state work permit, all starry-eyed with the anticipation of asking “Would you like fries with that?” then they can open a Roth IRA with their first paycheck.

It’s surprising how fast the money can add up. If a 12-year-old kid earns $5/hour for five hours/week, that’s at least $1250/year. That’s for simple projects like car washing, yardwork, home maintenance, and house painting (and writing guest posts for blogs). Not every child will have this focus or desire, but some of them will willingly get into the habit. The IRS will probably not send in the audit team if you pay your child $10/hour, as long as you properly declare the earned income.

First comes the federal paperwork. Page 10 of IRS Pub 15 (Circular E) says “Payments for the services of a child under age 18 who works for her parent in a trade or business are not subject to Social Security or Medicare taxes if the trade or business is a sole proprietorship or a partnership in which each partner is a parent of the child. If these services are for work other than in a trade or business, such as domestic work in the parent’s private home, they are not subject to Social Security and Medicare taxes until the child reaches age 21. However, see covered services of a child or spouse later. Payments for the services of a child under age 21 who works for his or her parent whether or not in a trade or business are not subject to federal unemployment (FUTA) tax. Although not subject to FUTA tax, the wages of a child may be subject to income tax withholding.” Good– no tax for SS, Medicare, or unemployment insurance.

Withholding is a different issue. IRS Pub 505 may require withholding, but crunching through form W-4 allowances and the withholding tables will probably show that the amount to be withheld is… $0. In other words your child may not have to pay any federal taxes on their earned income. I can’t make any blanket recommendations about withholding or taxes because each child’s earned and unearned (investment) income may trigger different tax situations.

I strongly recommend that you research your state and locality withholding and tax rules as well. You’re probably not going to have to withhold taxes from their earnings, but their earned income may trigger taxes.

So where do your kids open their first Roth account?

I phoned several of the largest investment companies to see whether they were familiar with the subject. The only company that gave me an argument was Fidelity, and they’ve been this way for years. Fidelity willnot open a Roth IRA for a child under the age of 18. They are unable to articulate a rationale (other than “Fidelity policy and IRS tax concerns”) but they’ve been that way since our daughter tried to open a Roth IRA with them in 2006. In fact it took me two tries to convince the customer-service representative that this “No Roth IRAs for minors” rule was Fidelity’s policy and not federal law.

Sharebuilder won’t open a Roth IRA for a minor, even if the parent/guardian is the subcustodian. This seems ironic for a company whose phone answering system announces “Hey, thanks for calling!” and plays reggae Muzak on the hold line. If they’re trying to appeal to a young, hip crowd then I guess they only want the ones older than age 18.

Schwab, TD Ameritrade, Vanguard, and T. Rowe Price will all set up Roth accounts for minors (as long as the parent/guardian is subcustodian). Most of them will start the application over a website and finish it with an additional form. Some are more flexible than others (TD Ameritrade has no minimum deposit while Schwab only requires $100). T. Rowe Price will set up a Roth IRA for as little as a $100/month contribution. Vanguard has the nation’s lowest mutual-fund company expense ratios but requires a $1000 minimum deposit for most accounts. Minimum deposits are no problem if your child has a high earned income, but if not then you may want to wait until January-March to make contributions across two different tax years at the same time.

Once your child turns age 18 (and is considered legally old enough to sign a contract) then they can apply to the company to have the sub-custodian removed from the account. No matter where you start a Roth IRA for a minor, you’re free to change to a new fund company once they turn age 18. This allows you to consolidate your kid’s accounts or other family accounts with one company.

Keep in mind that you should only help your kid(s) with Roth IRAs after your own retirement finances are on track. Kids can get college financial aid (or work for it) while nobody will lend you money for retirement. You also have to know your kid, because the Roth IRA becomes their property when they turn 18 years old. If they really wanted to, and if they exerted substantial personal effort, then they could cash in the IRA (paying the appropriate taxes & penalties) and buy a really sweet party weekend. If they want to make a penalty-free withdrawal of all their contributions and go buy themselves a really hot ride, then they can do that too. (Our college daughter is reading this post and thinking “Wait, what?!?”…) It’s always been their money, and once they turn age 18 then they can take control over it.

[…] biggest challenge was finding an investment firm that would sub-custody a Roth IRA for a minor. I talked with several companies before T. Rowe Price agreed to open an account in her name with me […]

[…] veteran & CFP Jeff Rose has started another movement over at Good Financial Cents! The Roth IRA movement raised a huge awareness in the financial independence corner of the blogosphere. Now he’s […]

[…] is the earned income requirements of a Roth IRA and Evolving PF does a great job covering it.Starting You Kid’s Roth IRA – One of the big benefits of a Roth IRA is the lack of age restrictions. As long as someone […]